Crowdfunding took real estate finance by storm in the past few years. The promise of a quick equity or debt raise paired with limited direct investor relations makes for a compelling deal financing model. Add the prospect that you can start hotel crowdfunding in only a matter of weeks, and the concept seems too good to be true.
Technology definitely made real estate syndication more efficient. Still, it takes some work to prepare your platform for quick raise. The good news is that building a hotel crowdfunding strategy that will consistently pay dividends is not too difficult.
Note: All information presented here is for discussion purposes only. Nothing in this article should be construed as legal or accounting advice. Please seek guidance from a professional qualified to guide you in making the most appropriate offer for your situation.
Step 1: Get Educated
Third-party equity is a great way to scale your real estate business allowing you to do more deals. Real estate is the most effective investment for using other people’s money (OPM) because the underlying asset provides security. Further, investors rely on your expertise in sourcing deals and executing on a successful real estate investment business plan.
Hotel crowdfunding is one part legal and nine parts sales and marketing. That is, most of your efforts will focus on finding investors and proving that you can do what you say.
Let’s start with the easy part.
The Securities and Exchange Commission (SEC) and state regulators govern real estate syndication under various rules. They want to know when you take money for a deal and require that you disclose all risks and performance expectations to the investor.
Registration and reporting requirements for a full public offering are expensive and onerous. They create a barrier for raising relatively small amounts of capital. Therefore, the government created exemptions to ensure fluid domestic, private capital markets, so long as they meet two major conditions.
- Don’t publicly advertise your deal – no “general solicitation”
- Only take money from wealthy or sophisticated investors – “accredited investors”
The JOBS Act of 2012 changed this dramatically and laid the foundation for modern syndication – crowdfunding. It requires that the sponsor of any advertised deal can only accept and must verify accredited investors into the syndication. The law also provided for the creation of two new capital formation structures.
These apply to all private placements – not just hotel crowdfunding.
The active, available real estate syndication registration exemptions include:
- Regulation D
- 506(b) – The traditional “Reg D” exemption that does not allow for general solicitation, but allows investors to self-certify accredited status
- 506(c) – The modern “Reg D” exemption that allows for general solicitation, but requires that a third party certify accredited status of each investor
- Regulation A – Considered a mini-IPO, the “Reg A” exemption allows you to raise up to $50 million per year for a single asset or a basket of properties from investors big and small – not only accredited investors – but it requires SEC approval and enhanced reporting
- Regulation CF – Similar to Regulation A, but you’re only able to raise up to $1 million with more relaxed reporting and regulatory requirements than Reg A
Regulation D is the most common tool used in exempt fund raising, but real estate companies are starting to embrace the other options. Fundrise pioneered the use of Regulation A for a series of REITs targeting a mass-audience with low minimum investment. Such a project is ambitious for many sponsors, but it beautifully shows off the power of real estate syndication.
Most real estate syndications – online and offline – use the Reg D exemption for raising funds.
The Investment Company Act of 1940 (’40 Act) governs mutual funds, private equity funds, hedge funds, and other companies that invest in securities for other people. Your syndication is probably exempt from registration under the ’40 Act so long as (1) it owns a majority of the common equity position in your deals and/or (2) it has less than 100 investors. However, be sure to confirm this on a deal-by-deal basis with your securities attorney.
Each state securities regulator also has an independent set of rules and requirements. These “Blue Sky” laws govern how you can approach investors and accept investment dollars in their state. They also dictate the type of disclosures and reporting required for soliciting funds in their state.
Hotel crowdfunding often involves marketing that covers multiple states, so be sure to confirm compliance with Blue Sky laws with your securities attorney.
Always rely on your attorney for securities guidance. A skilled legal practitioner is worth her weight in gold when it comes to building the foundation for your strategy, regardless of how educated you get.
Deal sponsors would traditionally advertise their platform rather than specific deals. They pitch deals to the investors in their database after verifying accredited status and investor fit during a “cooling off period.” The new regulations allow you to bypass that courting phase by pitching a deal directly.
While the new rules allow you to capture attention more efficiently, the traditional sales funnel is still very effective for building a sustainable, long-term investor database.
Sales is the act of engaging directly with a prospect, while marketing engages the audience through broadcast messages. Each is important to building trust.
The business development objective in an acquisitions capacity is to get an owner to sell you their building. Similarly, the objective in investor relations is to secure a reliable allocation for current and future investment.
Private capital markets are very inefficient. Good deals are hard to find, so the first step is to build awareness – this is the top of your funnel. The universe of investors will continue to shrink as they get to know your investment strategies. And you will continue to build trust and alignment with those that progress through each stage of the funnel.
Your sales and marketing funnel is the cornerstone of your hotel crowdfunding platform.
Omnipresence ensures the vitality of your funnel. Content marketing, SEO, Facebook advertising, public relations, and good old cold calls are common ways of building awareness. Get enough attention to bring prospects into the top of the funnel. Then, systematically move them toward making an investment.
You can do a lot of this on your own. However, the biggest bang for your buck will come from working with an experienced marketing consultant. Start to learn a bit about digital marketing so that you know if you’ve found the right marketing consultant.
Step 2: Lay the Groundwork
A crowdfunding platform’s ability to keep an investor audience engaged defines its success. This way, they are prepared to fund a deal on a moment’s notice. The success stories that get headlines like, “$4 million raised in 24 hours,” don’t happen overnight. That kind of success comes from months of proving your chops as a sponsor and being ready to strike while the iron is hot.
Your crowdfunding strategy defines the stakeholders, legal structures, and team that you will have to build.
Real estate syndication is simple. You are raising money in a single purpose entity (SPE) – usually a limited liability company or limited partnership – to fund some part of the capital stack. For example, you may need $4 million in equity for a $12.5 million deal. In this case, you’ll be sourcing $8.5 million from a traditional lender, and the remainder will come from a group of investors putting up a minimum of $40,000 each.
The investment minimum serves two purposes. It keeps your investor relations manageable, and it provides that you won’t trigger the ’40 Act.
A sustainable syndication business requires more than the minimum number of investors to fill a deal. Not every deal will exactly meet the needs of all investors in your audience. It takes time and patience to build your audience, so the strategy should focus on growing a little bit every day.
There’s no golden rule about the minimum number of investors in your database. Some investors will want to fund hundreds of thousands into your project, while others want to stay in the low tens of thousands.
Consistency is essential in your approach to filling the funnel.
Remember, you are building a platform, not pursing success on a single project. Ideally, investors you bring into your ecosystem are going to fund multiple deals, and they’ll be with you for a long time. You’re looking for marriage not speed dating. Focus on building a community rather than collecting investors to fund a single deal.
Budget? Whatever it takes to get people into your sphere of influence. This can be affordable or expensive. Start with what you have, then experiment with strategy additions until you have the right tactical mix.
Legal Components of a Syndication
Deals come together through the collaboration of a variety of players. You are the leader of this tribe and a key player in many of the processes. Your securities attorney will be a critical contributor in pulling together your first syndication, which includes three documents.
- Private Placement Memorandum (PPM) – This is the confidential offering document that gives an overview of the opportunity, sponsor credentials, associated risks, and legal disclosures. It contains forward looking statements that your attorney will scrub for liability.
- Subscription Agreement – This is the order to purchase shares in the SPE. It outlines the transaction requirements, acknowledges receipt and acceptance of disclosures and risks, and provides information to perform know-your-customer (KYC) and anti-money laundering (AML) background checks.
- Operating Agreement – This document directs the SPE, who manages it, and who decides on major decisions. The operating agreement also clearly defines the payment terms for each shareholder.
A package like this can take weeks to produce for your first deal. It is a major collaboration between you, your attorney, and your marketing team. The PPM is half marketing materials, a quarter deal details, and a quarter legal notice. Your attorney guides the process, but they can’t get very far without clarity in the marketing and deal specifics.
Find a securities attorney with experience in real estate syndications. A standard Regulation D offering will run anywhere from $5,000 to $25,000 depending on the complexity of the deal and included services, like state “blue sky” filings.
Consider aligning with an attorney with specific hotel crowdfunding experience if you plan to solicit funds online. This type of marketing requires a slightly different approach than a local, offline real estate syndication.
Pitch Your Strategy THEN Your Deal
Investors seek private placements for a variety of reasons. Universally, they’re interested in a good return on their investment with as little risk as possible. This risk-return balance is relative for each investor, but the concept carries into all areas of investing.
The sales and marketing process should offer comfort to investors that the sponsor will use their money exactly as proposed. Even though you will never guarantee an investment return, you can build trust that their investment will pursue a clearly-stated objective with a logically-sound outcome.
A robust sales funnel provides as much benefit to you as your prospects.
The sales funnel builds alignment and community within your real estate ecosystem. A first sales call or webinar should focus on who you are and how you make money. Any deal pitch this early on should be for example purposes only – a case study.
Pitch the deal after you know that there is an alignment of interests.
You’re making a sale at each stage of the funnel. The objective is to get the prospect to the next stage as quickly and confidently as possible.
Your collateral for building the audience will vary, but the basics include:
- Corporate presentation – A book or electronic presentation that details your history, qualifications, and business strategy
- Example deals – Brief case studies on how you acquired a deal, the execution, and the outcome
- Digital assets – An online presence where investors can learn more about you, your approach, and get comfortable with making an investment
Keep it simple when you start out and focus on the basics. Advanced dashboards and digital tracking tools are nice to have when you’re bigger, but they’re a distraction in the beginning. They prevent you from taking the vital first steps to building a database of investors.
Step 3: Engage
You’re ready to engage with your network. There is a fine line between too much and not enough preparation. A professional-looking corporate brochure with one or two case studies is enough to start. Develop the rest as you better understand the needs and desires of your audience.
You and your marketing consultant will develop a comprehensive plan for audience engagement. Still, the very first (and most important) thing you can do is build a mindset around three principles:
- Be open
- Be consistent
- Be proactive
Break free of the mental models that prevent your forward momentum.
Eliminate any presumptions about a person’s ability or desire to invest.
Manage your time and attention to focus on daily prospecting.
Shed the thought that you just need one more thing before you start. As an entrepreneur, you know that nobody enters a new venture knowing everything, and you’re never fully prepared for what waits around the corner. There are newbies entering the hotel crowdfunding space all the time. The only difference between them and you at the end of year one is your willingness to take the plunge. Overcome your mindset, and you can be making headlines in no time.